June 16, 2016

Experts Debate Policy Options for China's Transition

After nearly three decades of rapid economic growth, China today faces the challenge of economic rebalancing against the backdrop of slow and uncertain global growth. Although investment and exports have been a motor for growth, China is increasingly experiencing structural issues: widening inequality, overcapacity as a consequence of policy distortions, unsustainable environmental costs, volatile financial markets, and rising systemic risk.

On April 28–29, I attended the First Research Workshop on China's Economy, organized jointly by the International Monetary Fund (IMF) and the Atlanta Fed. The workshop, held at the IMF's headquarters in Washington DC, explored a series of questions that have emerged as China shifts toward a new growth model. Is this the end of the growth miracle? Will the Chinese renminbi one day be as important as the U.S. dollar? Should the rapidly increasing shadow banking activity in China be a source of concern? How worrisome is the rapid rise in China's housing prices?

Panelists shared their views on these and other issues facing the world's second-largest economy (or largest, if measured on a purchasing-power-parity basis). Plans are under way for a second workshop to be held in 2017.

The following is a nice summary of the research discussed at the workshop. It was originally published in the IMF Survey Magazine, and was written by Hui He, IMF Institute for Capacity Development, and Nan Li, IMF Research Department. Thanks to the IMF for allowing me to repost it here.

Is China's economic growth sustainable?
Understanding the source of China's tremendous growth was a recurring theme at the workshop. "China's economy combines enormous dynamism with huge distortions," observed Loren Brandt (University of Toronto). Brandt described his research based on China's firm-level data and emphasized that firm dynamics (entry and exit), especially firm entry, have been the main source of the productivity growth in the manufacturing sector.

Echoing Brandt's message, Kjetil Storesletten (University of Oslo) discussed regional growth disparities and showed that barriers preventing firms from entering an industry account for most of the disparities. Such barriers are more severe for privately owned firms in regions in which state-owned enterprises (SOE) dominate, he said.

In his keynote speech, Nicholas Lardy (Peterson Institute for International Economics) offered an upbeat view on China's transition to a new growth model, one in which the service sector plays a larger role than manufacturing. The bright side of the service sector, he noted, is its continued strong productivity growth. The development of financial deepening and the stronger social safety net are contributing to increased consumption, which helps to rebalance the economy.

However, he emphasized, SOE reforms remain critical as the service sector cannot provide a silver bullet for a successful transition.

Central bank's policy decisions
Several participants tried to discern how the People's Bank of China (PBC) conducts monetary policy. Tao Zha (of the Atlanta Fed's Center for Quantitative Economic Research and Emory University) found that the PBC reacts sharply when the gross domestic product's growth rate falls below its target, increasing the money supply by 11.5 percentage points for every 1 percentage point shortfall.

Mark Spiegel (Center for Pacific Basin Studies) discussed the trade-offs involved in Chinese monetary policy—for example, controlling the exchange rate versus maintaining inflation stability. He also argued that the heavy use of reserve requirements on banks as a monetary policy tool might have an unintentional consequence to reallocate capital from SOEs to more efficient privately owned firms and could therefore offset the resource misallocation caused by the easy credit to SOEs that banks granted in the high growth years.

Renminbi versus the dollar
Eswar Prasad (Cornell University and Brookings Institution) argued that China's capital account will become more open and the renminbi will be used more widely to denominate and settle cross-border transactions. But he also noted that legal and institutional constraints in China were likely to prevent the renminbi from serving as a safe-haven currency as the U.S. dollar does today.

Michael Song (Chinese University of Hong Kong) argued that rapidly rising shadow banking activity is an unintended consequence of financial regulation. Restrictions on deposit rates and loan-to-deposit ratios have led to the issuance by banks of "wealth management products" to attract savers with higher returns. Because these restrictions had a greater impact on small banks, the big state banks had more room to undercut the smaller banks by offering wealth management products with higher returns and then restricting liquidity to them in interbank markets, ultimately making the banking system more prone to liquidity distress and runs.

Hanming Fang (University of Pennsylvania) found that, except in big cities such as Beijing and Shanghai, housing prices in China's urban areas between 2003 and 2013 more or less tracked rising household incomes. In his view, the Chinese housing boom is thus unlikely to trigger an imminent financial crisis. He warned, however, that housing prices may fall rapidly if economic growth slows dramatically, and that such a development could, in turn, amplify the economic downturn.

Rising wage inequality
China's rapid growth over the past two decades has been accompanied by rising wage inequality, an issue highlighted by two conference participants. Dennis Yang (University of Virginia) explored the distributional effects of trade openness in China and found a significant impact on wage inequality of China's accession to the World Trade Organization in 2001.

Chong-En Bai (Tsinghua University) argued that the decline after 2008 of the skill premium—that is, the ratio of the skilled labor wage to the unskilled labor wage—can be explained by the Chinese government's targeted credit extension to unskilled labor-intensive infrastructure sector (as part of the fiscal stimulus following the global financial crisis). Such distortionary policies might have short-run growth benefits but could lead to long-run welfare losses, he said, especially when rural-to-urban migration has run its course.

By John Robertson, a senior policy adviser in the Atlanta Fed's research department

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To the extent that these factors are true, they may be affecting the decisions of other generations as well. Chart 1 below shows the overall average homeownership rate and homeownership rates by age group from 1982 to 2015. It's clear that homeownership rates have declined for everyone during the past 10 years, not just for millennials.

In fact, homeownership among young Generation Xers has fallen by a bit more than the millennial generation since the housing peak—declining 11 percentage points since 2005 compared with a decline of 9 percentage points for those under 35 years old.

Another interesting point of comparison is the mid-1980s to mid-1990s, a period in which the United States had a relatively stable share of owner-occupied housing of around 64.0 percent. During the subsequent housing boom, the homeownership rate climbed to a peak of 69 percent in 2004, only to fall back down to 63.7 percent in 2015, a level similar to that prevailing before 1995. However, each age group under age 65 has a somewhat lower homeownership rate than their same-aged peers had during the 1986–94 period.

The fact that the average U.S. homeownership rate is close to rates seen in the mid-1980s and mid-1990s while homeownership rates within age groups (under 65) are currently lower than their respective averages in the mid-1980s to mid-1990s suggests that factors other than age may be affecting the average person's decision to buy or rent.

To investigate what else may be going on, charts 2 and 3 show homeownership rates by family type and race. Between 2005 and 2015, the trend mirrors what's happening by age group. The tendency to own a home has been falling for all family types and races over the past decade. In general, economic incentives (or cultural attitudes) appear to have shifted the population toward renting and away from buying.

However, the picture is quite different when you compare homeownership rates by family type and race to the pre-1995 period. While homeownership rates within age groups are generally lower today, married couples, one-person households, and nonmarried, multiperson households were all more likely to own their home in 2015. Homeownership rates across race (except for blacks) were also higher in 2015 than in 1994.

So how do we interpret the fact that the overall homeownership rate is close to its average in the 1986 to 1994 period? Are millennials to blame? Yes. But so is everyone else under the age of 65. The data suggest that whatever is affecting millennials' homeownership decisions is applicable to older individuals as well. Further, it seems there are other, possibly larger, factors affecting homeownership, such as the changing face of America. Although homeownership rates by family types and racial groups are a bit above the level seen in 1994, the average person in 2015 was about as likely to live in a home that is owned or being bought. Thus, the shift in the distribution of the population toward racial groups and family types (and likely other factors) that tend to have lower homeownership rates is likely exerting an important influence on the overall homeownership rate.

Ellyn Terry, an economic policy analysis specialist in the Atlanta Fed's research department

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Very interesting trends. One question though: you say "The fact that the average U.S. homeownership rate is close to rates seen in the mid-1980s ... suggests that factors other than age may be affecting the average person's decision to buy or rent." Could not that just be because of demographic changes in the US (The population is on average older, and older people have higher homeowner rates) so that in fact it is all age related?

The sharp Race / Ethnicity disparities in homeownership that you chart raise the question whether trends in the distribution of household income and wealth would explain most of the decline in homeownership.

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August 01, 2014

What's behind Housing's June Swoon?

The housing market appears to have endured a particularly cruel month in June. Fairly good numbers on existing home sales provided some antidote to a second consecutive monthly decline in housing starts and a sharp decline in new home sales. But that palliative is less comforting than it might otherwise be given the fact that existing sales were still 2.3 percent below the June 2013 rate, and budding optimism diminished further with this week's unexpected drop off in the pace of pending home sales.

In her recent remarks before the Senate Committee on Banking, Housing, and Urban Affairs and before the House Committee on Financial Services, Federal Reserve Chair Janet Yellen took particular note of ongoing weakness in residential real estate:

The housing sector, however, has shown little recent progress. While this sector has recovered notably from its earlier trough, housing activity leveled off in the wake of last year's increase in mortgage rates, and readings this year have, overall, continued to be disappointing.

The statement following the conclusion of this week's meeting of the Federal Open Market Committee provided an exclamation point to Chair Yellen's commentary:

Information received since the Federal Open Market Committee met in June indicates that ... recovery in the housing sector remains slow.

The housing market was a bright spot in the economy from early 2012 to mid-2013, and there's no shortage of conjecture on why it has morphed into a source of concern. Reasonable hypotheses include reduced affordability brought on by higher mortgage rates and real estate prices, tighter lending conditions and ongoing balance sheet issues for households (think student debt), and supply constraints associated with rising construction costs and lot availability (at least in the most desirable locations, as examples here and here discuss).

In a March post in the Atlanta Fed's SouthPoint, affordability issues—specifically, interest rates and prices—constituted two of the top three explanations given by our broker and builder contacts in the Southeast for recent slower growth in the housing market. Earlier, we had examined the affordability issue in an Atlanta Fed Real Estate Research post. In it, we decomposed the affordability index that the National Association of Realtors (NAR) produces each month. We used our decomposition to show that the rebound in housing prices in 2012 served as a huge drag on affordability and, after six years of contributing to affordability, mortgage interest rates became a drag in mid-2013.

How—and why—has the affordability index changed since we last checked? The chart below provides an update through May 2014 (the latest date for which we have the data necessary for our decomposition):

On a year-over-year basis, affordability has fallen as a result of rising prices and last summer's uptick in interest rates. Still, affordability remains high by precrisis standards. And given that we have recently passed the anniversary of the first "taper talk," the impact of the interest rate component should fade if rates remain stable and thus become similar to, if not below, year-ago levels. Likewise, house price growth has decelerated and will continue to be less of a drag on affordability as measured by NAR.

It may be fair to attribute some of the recent softness in housing to affordability. But in light of the still relatively high readings of our index, it seems likely that the main culprits are one or more of the other factors discussed above.

By Carl Hudson, director of the Atlanta Fed's Center for Real Estate Analytics, and

Jessica Dill, senior economic research analyst in the Atlanta Fed's research department

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October 18, 2013

Why Was the Housing-Price Collapse So Painful? (And Why Is It Still?)

Foresight about the disaster to come was not the primary reason this year’s Nobel Prize in economics went to Robert Shiller (jointly with Eugene Fama and Lars Hansen). But Professor Shiller’s early claim that a housing-price bubble was full on, and his prediction that trouble was a-comin’, is arguably the primary source of his claim to fame in the public sphere.

Several years down the road, the causes and effects of the housing-price run-up, collapse, and ensuing financial crisis are still under the microscope. Consider, for example, this opinion by Dean Baker, co-director of the Center for Economic and Policy Research:

...the downturn is not primarily a “financial crisis.” The story of the downturn is a simple story of a collapsed housing bubble. The $8 trillion housing bubble was driving demand in the U.S. economy in the last decade until it collapsed in 2007. When the bubble burst we lost more than 4 percentage points of GDP worth of demand due to a plunge in residential construction. We lost roughly the same amount of demand due to a falloff in consumption associated with the disappearance of $8 trillion in housing wealth.

The collapse of the bubble created a hole in annual demand equal to 8 percent of GDP, which would be $1.3 trillion in today’s economy. The central problem facing the U.S., the euro zone, and the U.K. was finding ways to fill this hole.

In part, Baker’s post relates to an ongoing pundit catfight, which Baker himself concedes is fairly uninteresting. As he says, “What matters is the underlying issues of economic policy.” Agreed, and in that light I am skeptical about dismissing the centrality of the financial crisis to the story of the downturn and, perhaps more important, to the tepid recovery that has followed.

Interpreting what Baker has in mind is important, so let me start there. I have not scoured Baker’s writings for pithy hyperlinks, but I assume that his statement cited above does not deny that the immediate post-Lehman period is best characterized as a period of panic leading to severe stress in financial markets. What I read is his assertion that the basic problem—perhaps outside the crisis period in late 2008—is a rather plain-vanilla drop in wealth that has dramatically suppressed consumer demand, and with it economic growth. An assertion that the decline in wealth is what led us into the recession, is what accounts for the depth and duration of the recession, and is what’s responsible for the shallow recovery since.

With respect to the pace of recovery, evidence supports the proposition that financial crises without housing busts are not so unique—or if they are, the data tend to associate financial-related downturns with stronger-than-average recoveries. Mike Bordo and Joe Haubrich, respectively from Rutgers University and the Federal Reserve Bank of Cleveland, argue that the historical record of U.S. recessions leads us to view housing and the pace of residential investment as the key to whether tepid recoveries will follow sharp recessions:

Our analysis of the data shows that steep expansions tend to follow deep contractions, though this depends heavily on when the recovery is measured. In contrast to much conventional wisdom, the stylized fact that deep contractions breed strong recoveries is particularly true when there is a financial crisis. In fact, on average, it is cycles without a financial crisis that show the weakest relation between contraction depth and recovery strength. For many configurations, the evidence for a robust bounce-back is stronger for cycles with financial crises than those without...

Our results also suggest that a sizeable fraction of the shortfall of the present recovery from the average experience of recoveries after deep recessions is due to the collapse of residential investment.

From here, however, it gets trickier to reach conclusions about why changes in housing values are so important. Simply put, why should there be a “wealth effect” at all? If the price of my house falls and I suffer a capital loss, I do in fact feel less wealthy. But all potential buyers of my house just gained the opportunity to obtain my house at a lower price. For them, the implied wealth gain is the same as my loss. If buyers and sellers essentially behave the same way, why should there be a large impact on consumption? *

I think this notion quickly leads you to the thought there is something fundamentally special about housing assets and that this special role relates to credit markets and finance. This angle is clearly articulated in these passages from a Bloomberg piece earlier in the year, one of a spate of articles in the spring about why rapidly recovering house prices were apparently not driving the recovery into a higher gear:

The wealth effect from rising house prices may not be as effective as it once was in spurring the U.S. economy...

The wealth effect “is much smaller,” said Amir Sufi, professor of finance at the University of Chicago Booth School of Business. Sufi, who participated in last year’s central-bank conference at Jackson Hole, Wyoming, reckons that each dollar increase in housing wealth may yield as little as an extra cent in spending. That compares with a 3-to-5-cent estimate by economists prior to the recession.

Many homeowners are finding they can’t refinance their mortgages because banks have tightened credit conditions so much they’re not eligible for new loans. Most who can refinance are opting not to withdraw equity after the first nationwide decline in house prices since the Great Depression reminded them home values can fall as well as rise...

Others are finding it difficult to refinance because credit has become a lot harder to come by. And that situation could worsen as banks respond to stepped-up government oversight.

“Credit is going to get tighter before it gets easier,” said David Stevens, president and chief executive officer of the Washington-based Mortgage Bankers Association...

“Households that have been through foreclosure or have underwater mortgages or are otherwise credit-constrained are less able than other households to take advantage” of low interest rates, Fed Governor Sarah Bloom Raskin said in an April 18 speech in New York.

(I should note that Sufi et al. previously delved into the relationship between household balance sheets and the economic downturn here.)

A more systematic take comes from the Federal Reserve Board’s Matteo Iacoviello:

Empirically, housing wealth and consumption tend to move together: this could happen because some third factor moves both variables, or because there is a more direct effect going from one variable to the other. Studies based on time-series data, on panel data and on more detailed, recent micro data point suggest that a considerable portion of the effect of housing wealth on consumption reflects the influence of changes in housing wealth on borrowing against such wealth.

That sounds like a financial problem to me and, in the spirit of Baker’s plea that it is the policy that matters, this distinction is more than semantic. The policy implications of an economic shock that alters the capacity to engage in borrowing and lending are not necessarily the same as those that result from a straightforward decline in wealth.

Having said that, it is not so clear how the policy implications are different. One possibility is that diminished access to credit markets also weakens policy-transmission mechanisms, calling for even more aggressive demand-oriented “pump-priming” policies of the sort Dean Baker advocates. But it is also possible that we have entered a period of deep structural repair that only time (and not merely government stimulus) can (or should) engineer: deleveraging and balance sheet repair, sectoral resource reallocation, new consumption habits, new business models driven by both market and regulatory imperatives, you name it.

In my view, it’s not yet clear which policy approach is closest to optimal. But I am fairly well convinced that good judgment will require us to think of the past decade as the financial event it was, and in many ways still is.

*Update: A colleague pointed out that my example describing housing price changes and wealth effects may be simplified to the point of being misleading. Implicitly, I am in fact assuming that the flow of housing services derived from housing assets is fixed, a condition that obviously would not hold in general. See section 3 of the Iacoviello paper cited above for a theoretical description of why, to a first approximation, we would not expect there to be a large consumption effect from changes in housing values.

By Dave Altig, executive vice president and research director at the Atlanta Fed

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A primary residence's home price reflects the economic value to a homeowner of living in an area. The major part of the economic value of living somewhere is future expected earnings. The home price will not exceed the economic value to the marginal buyer. When expectations of future earnings decline home prices will decline across the board.

Using housing wealth is just intertemporal substitution. Refinancing is self-financing with homeowners self-qualifying themselves for the mortgage debt. Bank restrictions can limit refinancing but most homeowners will not refinance if they belive they cannot afford to repay the debt or sell above mortgage amounts.

Home price appreciation and the ability to pay back the refinancing or first mortgage debt depend on expectations of a continuation of wage growth to the borrower, or future homebuyer (if one expects to sell prior to debt payoff). A decline in expected wage growth rates (productivity) will cause home prices to decline, unemployment to increase and wages to stagnate.

Wage and GDP growth are linked to capital investment and there has been a sharp decline in US capital investment, which is continuing. If the decrease in capital investment was anticipated (expected), then whatever shock caused the decline in investment is also causing the continuing slow recovering.

Home price decline and the continuing slow recovery have common causes.

For those of us between 20-40, first time buyers or up-graders, high land/building prices are very much a drag on our budget. This also includes high rents for the businesses we are starting.

My parents were able to buy their first house in their early twenties on a single blue collar income with a 40% down payment that took only a few years to accumulate. That seems utterly utopian among my peers.

In the long term, high housing prices is a drag on the economy. Do high gasoline prices help people because they feel their cars' tank is worth more?

The only people benefiting from rising house prices are people speculating, those who buy or build with the intent to sell.

Mr. Altig, the reason housing mattered so much in the late 2000s, and more than it had in previous times, was precisely because the housing "wealth effect" was just about the only thing normal people had going for them.

While wealth seemed to be increasing in the financial sector, much of that, as we learned, was piggy-backed on the notion that houses would always increase in value--and on the widespread idea that any loan was a good loan because you could bundle it and sell it off.

Much of the rest of the country's GDP improvements came in tech, but tech lately tends to destroy the wealth of everyday people as it automates and outsources their jobs.

That's why the late 1990s/early 2000s real estate boom needs to be seen as a response to a fading job market. The end of job security and the ever-declining wages for ordinary workers meant millions of people taking up the business of flipping houses.

The bubble's runup cannot be understood except in this context. Most people did not want to become mortgage fraudsters. But economic circumstances changed to make house-flipping and mortgage fraud the most (and mostly the only) lucrative option for people who used to be bank tellers and salesmen and low-level software developers.

And right: there has as yet been no policy changes designed to either increase wages or create honest jobs for everyday people. Absent action on this concern, the only question before us is, What will bubble next?

During the bubble, many folks bought houses with little or no downpayment. Many bought houses with loans that were not really affordable for them in the long term because of the terms of the loan or the because the actual issuance of the loan was, shall we say, irregular. So when rates rose or prices went down, they had no buffer.

Many who had houses they could afford or even paid off took the wealth effect somewhat literally and spent it, in the form of equity loans, thanks to the same low rate, loose terms, and irregularities. The "wealth" they had just spent turned out to be a short-lived ephemeral delusion, but the debt was durable.

I find it stunning that people still don't understand this basic aspect of the reality of the erstwhile "Bush Boom".

It was all borrowed money! Trillions! Flowing to millions of households, and creating millions of jobs via this stealth stimulus.

But it was all ponzi-based, as the specuvesting was being supported by more and more "suicide" lending products and outright fraud at all levels of the FIRE sector, from customer-facing brokers to the ratings agencies stamping AAA on CDOs.

What got the housing appreciation train going in 2002 was Greenspan's lower interest rates and the 2001-2003 tax cuts, which empowered homebuyers to bid up the cost of housing more.

Momentum kept the game going in 2004, but the smart money started getting out in 2005, leaving the field to idiots stampeded into buying then or being priced out forever (plus millions of specuvestors like Casey Serin playing with OPM).

Drop $100B/month onto the middle class again and we'd have a helluva great economy again, like we did in 2004-2005.

Don't forget the fraudulent nature of the house price increases in much of the country.

In many many places, loans were issued and properties flipped because lenders and/or borrowers were blatantly writing fraudulent loan paperwork. Prices were inflated above sustainable economic value as a result. Those who sold received ill-gotten gains; those who bought and held were forced to pay higher prices than they should have - they were robbed. Those who flipped paper received ill-gotten gains; those who bought the AAA-rated bonds and didn't get their interest or principal back were robbed. Those who borrowed against the higher, fraudulent prices, thinking that rising prosperity and declining rates would make refinancing later affordable, were tricked too. In fact, never in the course of human events have so many been robbed so badly, by so few.

Wondering why the eventual collapse was so painful is a ludicrous pastime for "economists". The net worth of the overwhelming majority of Americans is entirely in their home equity. Or was. Many folks lost their entire net worth. Rebuilding that takes time in the best of circumstances, and even more so now, given the structural problems in the economy. Furthermore, many of these folks were burned so badly that they will refuse to partake in a repeat.

The Federal Reserve, among many other institutions, was AWOL when it should have been regulating to prevent all of this. Greenspan is recently on record claiming that fraud is a law-enforcement issue, not a Federal Reserve issue. That is nonfeasance. The Fed has regulatory powers and anything that leads to "bezzle" on the balance sheets (to borrow a term from J.K. Galbraith) is also a regulatory issue because it means banks haven't got the capital base they claim to have. There was plenty of evidence available to those willing to look for it.

I suspect that 100 years from now, History is not going to look kindly on anything the Fed did from about 2002-present.

You should look at Richard Koo's work on balance sheet recessions to get an understanding of the dynamic.

Simply put, if a household or business owns assets financed by debt,and that asset has declined in value, the household reduces consumption and increases savings/reduces debt to reduce the risk of default.

It is important to understand because debt is reduced under these circumstances irrespective of the interest rate.

Here's a table, compiled by former Fed Governor Larry Lindsey, that explains much of the pain from the housing-bubble collapse. The lower 75% of households (by wealth) have still not recovered their peak wealth.

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March 11, 2013

You Say You’re a Homeowner and Not a Renter? Think Again.

As we’ve said before, we’re suckers for cool charts. The latest that caught our eye is the following one, originally created by the U.S. Bureau of Labor Statistics (BLS). It highlights the relative importance assigned to the various components of the consumer price index (CPI) and shows where increases in the index have come from over the past 12 months.

It probably won’t surprise anyone that the drop in gasoline prices (found in the transportation component) exerted downward pressure on the CPI last year, while the cost of medical care pushed the price index higher. What might surprise you is the size of that big, blue square labeled “housing.” Housing accounts for a little more than 40 percent of the CPI market basket and, given its weight, any change in this component significantly affects the overall index.

This begs the question: In light of the recent strength seen in the housing market—and notably the nearly 10 percent rise in home prices over the past 12 months—are housing costs likely to exert more upward pressure on the CPI?

Before we dive into this question, it’s important to understand that home prices do not directly enter into the computation of the CPI (or the personal consumption expenditures [PCE] price index, for that matter). This is because a home is an asset, and an increase in its value does not impose a “cost” on the homeowner. But there is a cost that homeowners face in addition to home maintenance and utilities, and that’s the implied rent they incur by living in their home rather than renting it out. In effect, every homeowner is his or her own tenant, and the rent they forgo each month is called the “owners’ equivalent rent” (or OER) in the CPI. OER represents about 24 percent of the CPI (and about 11 percent of the PCE price index). The CPI captures this OER cost (sensibly, in our view) by measuring the cost of home rentals (details here). So whether the robust rise in home prices will influence the behavior of the CPI this year depends on whether rising home prices influence home rents.

So what is likely to happen to OER given the continued increase in home prices? Well, higher home prices, in time, ought to cause home rents to rise, putting upward pressure on the CPI. Homes are assets to landlords, after all, and landlords (like all investors) require an adequate return on their investments. Let’s call this the “asset market influence” of home prices on home rents. But the rents that landlords charge also compete with homeownership. If renters decide to become homeowners, the rental market loses customers, which should push home rents in the opposite direction of home prices for a time. Let’s call this the “substitution influence” on rent prices.

Consider the following charts, which show three-month home prices and home rents (measured by the CPI’s OER measure). It’s a little hard to see a clear correlation between these two measures.

So we’ve separated these data into their trend and cycle components (using Hodrick-Prescott procedures, if you must know) shown in the following two charts. Now, if one takes the trend view, there is a clear positive relationship between home prices and home rents. This is consistent with the asset market influence described above. But also consider the detrended perspective. Here, home prices and home rents are pretty clearly negatively correlated. This, to us, looks like the substitution influence described above.

So let’s get back to the question at hand. What do rising home prices mean for OER and, ultimately, the behavior of the CPI? Well, it’s rather hard to say because the link between home prices and OER isn’t particularly strong.

Not definitive enough for you? OK, how about this: We think the recent rise in home prices will more likely lean against the rise in OER for the near term as the growing demand for home ownership provides some competition to the rental market. But, in time, these influences will give way to the asset market fundamentals, and rents are likely to accelerate as returns on real estate investments are reaffirmed.

Comments

When comparing house prices to OER, it's worthwhile to separate out the influence of interest rates. So instead of comparing house prices directly, it is useful to compare the P+I payment on that loan ammount at the going rate for 30 year mortgages.

So, let me see if I get this right: the inflation rate is calculated in part from a mathematical construct representing a cost that no one actually pays, based on surveys asking people what they think their house is worth in rent. (And of course we know that homeowners are not biased in their view of the worth of their house!) I live in Cambridge, which has high rents and low vacancy rates. I'm giving me a pretty good deal on my rent--I should be charging me a lot more! As a practical matter I do regard the difference between my mortgage and what it would cost to rent around here as a kind of savings (thanks, super-low interest rates!). But then, you can also see how, since my mortgage is fixed, I am more concerned with inflation of costs that come directly out of my pocket, such as maintenance and food. Sadly, plumbers don't want to get paid in nontransferable theoretical constructs.

A simpler hypothesis is that the CPI determination of OER is flawed. One might then be concerned that this bad OER measurement distorts the CPI and could lead to serious macro consequences due to the widespread use of a bad CPI.

And indeed, if one takes time to read how OER is actually determined, one is not heartened. The quote is below. The bottom line is that some owners are SURVEYED and asked their OPINION about what their house WOULD rent for, if they rented it! I am flabbergasted by this, because in my experience owner's responses are horribly biased and not at all reflective of actual rental market conditions. Many owners haven't even looked at renting for years, decades, etc. THERE HAS TO BE A BETTER WAY TO MEASURE 24% of the CPI! (The fact that this isn't being done, despite the weight and importance of this part of CPI, is a significant "tell" that no one actually cares about getting anything factually right in economics...)

From the link given in the article above:

" ' ... Owners’ equivalent rent of primary residence (OER) is based on the following question that the Consumer Expenditure Survey asks of consumers who own their primary residence:
“If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?”

... From the responses to these questions, the CPI estimates the total shelter cost to all consumers living in each index area of the urban United States. ' "

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October 19, 2012

Investor Participation in the Home-Buying Market

What is the investor share of the home-buying market, and in what direction is the trend moving? We have been asking ourselves this question for the past few months, because the answer can help to inform what type of housing recovery we are seeing. Is it being driven by owner occupants or investors?

If it is being driven by investors, does this signal an emerging aversion to homeownership? Or, instead, does this simply signal that owner occupants are unable access mortgage finance and that, for now, owner occupants will be unable to maintain the share of market they once held? If we see that the owner occupant share is increasing, this observation could offer some support that the housing recovery has legs. The conclusion that the investor share is increasing, then, may suggest that we will see home sales activity fall off once prices rise to the point that it no longer makes sense for investors to continue buying.

To help us pinpoint the share and trend in the investor participation in the home-buying market, we polled our real estate business contacts to get a better sense for our regional portrait of investor market share. When asked to describe the distribution of home buyers in their market, our business contacts from the Southeast (excluding Florida) noted that one-fifth of home sales, on average, were to investors. Once we added Florida into our tally of Southeast contacts, just over one-fourth of sales, on average, were to investors.

Since this was the first time we posed this question to our business contacts, we lacked information on the directional trend. To address this information gap, we asked our business contacts how sales to investors had changed between the second and third quarters of 2012. More than half reported no change or a slight decline in home sales to investors, unless you include the Florida observations. A closer look at Florida reveals that nearly two-thirds of our business contacts reported that sales to investors in Florida have increased over the past quarter. The investor dynamic in Florida all seems to add up, especially given the strong demand from international buyers and cash investors in South Florida. This dynamic was discussed in the latest issue of EconSouth.

We thought it would also be informative to ask our business contacts about their expectations for future investor home buying activity. For the Southeast less Florida, more than half of our business contacts indicated that they did not expect there to be much change in investor market share over the next year. For Florida, more than half of the business contacts continued to indicate that they expected share of sales to investors to increase.

While the intelligence gathered from our business contacts aligns nicely with external data sources, we still had a few concerns that made us question the directional trend of these data.

The first source of concern is two-fold. First, brokers serve as a key input to our business contact poll and others like it. In and of itself, this is not a big deal because brokers are valued business contacts that provide us with a frequent and timely pulse on changing conditions in local real estate markets. What is slightly problematic is that brokers often rely heavily on the Multiple Listing Service (MLS), which brings me to my second point. We have also been hearing through business contacts (and this is echoed in the media here) that the composition of the investor pool has shifted from primarily smaller mom/pop-type investors to larger institutional investors that, more often than not, purchase properties at auction or directly from banks. Often, these sales take place before the properties get listed on MLS.

So, how involved are brokers in transactions that take place before MLS? Is this particular slice of investment activity being picked up by our sources? If not, how much do we really know about the share and directional trend of investor participation in the home buyer market?

Media coverage (here, for example) of these institutional investors often describes scenes at local auction in which institutional investors outbid smaller investors and have gone so far as to expand their presence and show up at auctions where properties at the fringe (in less desirable locations) are being sold. This piece of information, alone, leads me to believe that these larger investors have displaced smaller investors. Therefore, it would not necessarily be correct to think of properties acquired by institutional investors as something in addition to the properties purchased by smaller mom/pop investors. Instead, many of the mom/pop investors have been priced out of the market and replaced by institutional investors.

Another related concern involves the timing and strategy of these institutional investors. Why would institutional investors flood local real estate markets at the same time that inventory is tightening and home prices are beginning to stabilize and modestly increase in many markets? Wouldn't this squeeze their yields and make it less desirable for them to continue to ramp up their efforts?

To help provide some insight into the institutional investor, I created a table of information to provide a profile on a few institutional investors often cited by the press. It is important to mention that this table was not intended to be all-encompassing and that the source of information is entirely secondary.

What this table implies is that institutional investors ramped up activity earlier this year and have indeed concentrated their investment activity within a handful of markets that were hit hard by the housing downturn. Acquisition strategies for these larger investors focus on mostly low-priced, distressed properties.

This makes sense. The markets hit hardest by the housing downturn are also the markets where distressed properties make up a significant portion of the available homes for sale. However, data from CoreLogic indicates that the share of distressed sales is steadily declining over time. As the distressed sales share continues to shrink and home prices continue to rise, it stands to reason that investment activity will shrink (or continue to shrink).

It was recently noted that Och-Ziff Capital Management Group LLC, a large institutional investor (not outlined in the table above), announced that it intends to exit this line of business. Perhaps it is just a matter of time before other large investors follow suit.

By Jessica Dill, a senior analyst in the Atlanta Fed’s Center for Real Estate Analytics

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Another approach to this general topic is to track sales vs. mortgage purchase applications. Sales to investors generally do not require a single property mortgage. Sales were much stronger than applications in 2011 and the first half of 2012. More recently applications have picked up. This is consistent with investors being more active last year and early this year. Owner occupants now seem to have become more dominant.

Jessica, this seems to be the case everywhere. Living in Panama there are a number of Americans who initially moved down here in the boom and had properties back home. Some of them have had to let those properties go, as even if they returned home, they would not be able to keep up the payments and the cost of living.

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August 29, 2012

Rising House Prices: The Good Fortune Spreads

On the heels of a rash of pretty good news related to residential real estate—including yesterday's pending home sales report—the June S&P/Case-Shiller report on housing prices checks in with
positive monthly gains across all markets in its 20-city composite for the second month in a row. What's more, the index posted its first year-over-year gain since last summer.

[T]he housing market is steadily improving and is poised to contribute to economic growth this year. Modest economic growth and job gains are encouraging more Americans to buy homes.

The widespread nature of price firming evident in the Case-Shiller index is strikingly confirmed by looking at even more disaggregated data. The following chart shows June year-over-year price growth by zip code, before the crisis hit and since, based on data available from CoreLogic:

The sample represented by the chart covers about 21 percent of all of the zip codes in the nation, and is based (like Case-Shiller) on a repeat-sales methodology.

The striking aspect, of course, is that there haven't been price increases in the majority of the sample's zip codes since before 2007 (although there was improvement evident in 2010, followed by the re-emergence of broader weakness in 2011). Furthermore, the uniformity of the picture becomes even more apparent when you look market by market (across which the experience is not so uniform). Two of the big comeback stories—Miami and Phoenix—were uniform in the breadth of the suffering across their metro areas during the worst of the slump and are now just as uniform in recovery:

Folks in Atlanta, on the other hand—which remains the big negative outlier in the year-over-year Case-Shiller statistics—are just as uniform as Miami and Phoenix, but in the pain rather gain department:

Even so, the Atlanta market has had two consecutive months of Case-Shiller housing price appreciation and experienced the largest monthly percentage gains in the June report. It does appear that the rising residential real estate tide is raising most boats.

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the same analysts who panned the homebuyer tax credits as temporary market distortions are ignoring the temporary distortion in home prices caused by operation twist induced record low interest rates, which effectively reduces the amount a buyer pays for a home even as the list price rises..

the average interest rate on fixed rate 30 year mortgages in July was 3.55%, a full percentage point lower than Freddie Mac's had the 30 year mortgage rate at a year ago...a simple mortgage calculation shows that the monthly cost per $100,000 on a 30 year mortgage in july of 2012 was $451.84, compared to the $509.66 per $100K one would have paid monthly on a 30 year mortgage last July; that means to buy the same house a year ago would have cost a potential homeowner 12.8% more in payments monthly than it would cost under current interest rate regimes...so even should July's home price indexes show a 2.8% year over year gain in the principal price of the house, it would mean that potential home buyers are still commiting 10% less to homeownership than they were a year ago...the so-called housing recovery is merely a fiction of low interest rates, which will not stay this low forever...

Just like the unemployment figures, which don't reflect the numbers of those unemployed who have exited the job market, the housing data do not reflect those houses that have been taken off the market nor do they reflect those houses that have not been put on the market due to depressed prices. Once a steady trend of home sales begins, those who have been waiting on the sidelines will put their homes on the market driving prices down once again. The solution is not short term. The reality is, we are in the midst of (and have been for the past three years) the greatest redistribution of wealth in our Nation's history.

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September 01, 2011

The pull between spending and saving

In a speech on Wednesday, Atlanta Fed President Dennis Lockhart talked about how the economic outlook is being shaped by the process of deleveraging (reducing debt and increasing saving) that is occurring in the economy.

By way of background, President Lockhart emphasized the important role that some amount of debt plays in economic growth: while difficult to measure precisely, research suggests that debt levels that get high enough are associated with extended periods of subpar economic growth.

"Debt is not in and of itself a bad thing. Debt supports economic growth by allowing households, businesses, and governments to smooth their spending and investment over time. Borrowing and lending can help facilitate the allocation of capital to productive uses in the economy. But high debt levels can also result in lower economic growth, a point that Stephen Cecchetti, of the Bank for International Settlements, made in a paper presented at the Kansas City Fed's symposium in Jackson Hole, Wyo., last week."

Relative to the 1990s, the last decade witnessed a surge in borrowing by the nonfinancial sector (comprising households, nonfinancial businesses and governments). Indeed, as President Lockhart noted:

"Relative to the size of the U.S. economy measured in terms of GDP, the total domestic debt of nonfinancial sectors of the economy reached 248 percent in 2009, increasing by almost 75 percentage points over the previous decade alone."

While no longer growing, the overall debt position of the nonfinancial sector has barely declined since peaking in 2009.

How did we get to this point? Much of the increase in total debt during the 2000s was in the form of real estate debt, and most of that was by households and unincorporated businesses (mostly sole proprietorships and partnerships). During the 1990s the mortgage debt of households was relatively stable at around 45 percent of GDP, but it increased to a peak of 76 percent of GDP in 2009. Over the same period, mortgage debt for unincorporated businesses increased from around 12 percent of GDP to almost 20 percent.

Because real estate is relatively expensive, it is not surprising that mortgage debt heavily influences the overall debt burden of individuals. Rapidly rising home values from the late 1990s to 2006 supported the notion that housing was a good asset to purchase…until it wasn't. According to the S&P Case-Shiller national home price index, home values have declined by more than 30 percent from their peak in 2006, after having increased by more than 150 percent compared with the previous decade.

From their peak in 2009, debt levels for households and unincorporated businesses have declined relative to GDP notably by a combined 15 percentage points. Reduced mortgage debt accounted for three quarters of that decline. As President Lockhart notes, repairing the balance sheet of the household sector, just as it does for businesses, can occur through some combination of debt reduction and increased savings.

"Household deleveraging has occurred mostly through a combination of increased savings, debt repayment, and also debt forgiveness. At the same time, there has generally been less access to credit for households as a result of stricter underwriting standards. The inability to qualify for home equity loans and other forms of credit has slowed the pace at which new debt is taken on by households replacing paid-down debt. The effect is to reduce their debt burden over time."

In contrast to households and unincorporated businesses, the amount of debt owed by the nonfinancial corporate sector has not declined very much since 2009. Nonfinancial corporations increased borrowing during the second half of the 2000s. But most of the debt growth was from increased issuance of corporate bonds. Since its historical peak in 2009, the total debt of the nonfinancial corporate sector has remained at around 50 percent of GDP, as continued bond issuance has largely offset declines in other types of corporate borrowing.

If individuals are aggressively reducing their debt burden, and corporations haven't increased their overall borrowing, why hasn't the overall debt burden of the nonfinancial sector of the economy declined since 2009? The primary reason is that the amount of federal government debt has increased sharply in recent years—from 35 percent of GDP in 2007 to about 65 percent of GDP in early 2011.

"While the private sector—households and businesses—has made notable progress in lowering its debt burden, discussions of how to reduce public debt have only just begun. The government still needs to introduce major policy changes to put public debt on a sustainable path. Demographic trends, which I referenced earlier, will make public debt reduction even more challenging."

How long will the deleveraging process take to play out? I'm pretty confident that nobody really knows precisely, but President Lockhart suggests that we may be closer to the beginning of the process than the end:

"Rebalancing simply takes time. A 2010 report by McKinsey surveyed 32 international periods of deleveraging following financial crises and found that, on average, the duration of these episodes was about six and a half years. U.S. debt to GDP peaked in the first quarter of 2009. So, by that standard we are much closer to the beginning than the end of our deleveraging process."

Lockhart also makes the point that this necessary structural adjustment has consequences for the medium-term outlook:

"When economies are deleveraging they cannot grow as rapidly as they might otherwise. It is obvious as consumers reduce spending they divert more of their incomes to paying off debt. This shift in consumer behavior increases the amount of capital available for financing investment. But higher rates of business investment are not likely to fully offset weakness in consumer spending for some time, as businesses continue to grapple with uncertainties about the future."

From a monetary policy perspective, slower growth as a result of deleveraging raises important challenges:

"To my mind, it's becoming increasingly clear the challenge we policymakers face is balancing appropriate policy responses for the near to medium term with what's needed for the longer term. In other words, we must continue to help the economy achieve a healthy enough cyclical recovery, especially with unemployment high and consumer spending lackluster. At the same time, we must recognize the longer-term need for directionally opposite structural adjustments, including deleveraging."

How does President Lockhart size up the role of monetary policy in this context?

"Given the weak data we've seen recently and considering the rising concern about chronic slow growth or worse, I don't think any policy option can be ruled out at the moment. However, it is important that monetary policy not be seen as a panacea. The kinds of structural adjustments I've been discussing today take time, and I am acutely aware that pushing beyond what monetary policy can plausibly deliver runs the risk of creating new distortions and imbalances.

"We may find, as economic circumstances evolve, that policy adjustments are required. In more adverse scenarios, further policy accommodation might be called for. But as of today, I am comfortable with the current stance of policy, especially considering the tensions policy must navigate between the short and long term and between recovery and the need for longer-term structural adjustments."

By John Robertson, vice president and senior economist in the Atlanta Fed's research department

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This post clearly shows that movements in household leverage (a rise in the last expansion and a fall that began in the recession) are a signature of the latest economic cycle. However, there are a number of important 'why' questions that the aggregate time series cannot answer. It is unlikely that a change in the 'taste for debt' alone can explain the changes in leverage. Moreover, different explanations for the levering up have very different policy prescriptions and forecasts for deleveraging going forward. Just to name two examples, Atif Mian and Amir Sufi have several papers that suggest the loosening of the supply of credit led to the levering up. In contrast, Tyler Cowen in the The Great Stagnation points to the over-confidence of households and other agents about income prospects. There are other possible explanations and the truth may be a combination. So while the post raises some interesting questions with aggregate time series, there is a lot of empirical work that can and should be done with micro data, like the Survey of Consumer Finances and the American Life Panel.

Sumner writes a lot of crap, but let's face it, he's right on at least two counts:

1. There's no such thing as neutral monetary policy. Before 'waiting to act' for fear of causing "new distortions", consider the distortions you may presently be causing.

2. Monetary policy should target the forecast. Why, for example, are you doing this to inflation expectationshttp://research.stlouisfed.org/fred2/graph/?g=1WL
with one-off programs of limited duration announced in advance?! I could come up with a better monetary policy in my basement.

Once you stabilize inflation expectations, consider raising them to 4% for a while, to ease the burden of the above household debt, help correct our foreign trade imbalances (Sumner is also right that international trade is not a zero-sum game), and spur corporate investment.

Then tell Barney Frank to cut the crap and stop letting people like me buy houses at 30:1 margin, as I just did in June. The greater the portion of a loan that is secured by the asset it purchases, the stronger the feedback loop between willingness to lend and prices (about the only thing Soros gets right), which is the only way you got those curves above.

Sure, there are political problems around creating inflation. That's where Bernanke needs to start eating his oysters and stop standing around blinking his eyes like a toad lickin' lightning. I'll tell you a secret: Bernanke is smarter than Rick Perry. Why let such facts go unnoticed? But as is obvious from the above speech, he can't even defeat his critics in his own organization (not that Lockhart is one, but it seems to me he's addressing some of them).

I think the problem with society today is the inability to defer gratifcation that is until recently. Get a collage degree borrow to pay for it' buy a new car borrow to pay for it' need a bigger house borrow to pay for it' why save to pay when you can play now would be a good way to decribe things up until about five years ago.

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May 13, 2011

Just how out of line are house prices?

In Wednesday's post, I referenced commentary from several bloggers regarding the sizeable decline in housing prices reported by Zillow earlier this week. As I discussed yesterday, the rat-through-the-snake process of working down existing and prospective distressed properties is likely far from over, and how that process plays out will no doubt have an impact on how much prices will ultimately adjust.

Recently, Barry Ritholtz's The Big Picture blog featured an update of a New York Times chart that suggests there will be a significant adjustment going forward:

Prior to the crisis, I was persistently advised that the better way to think about the "right" home price is to focus on price-rent ratios, because rents reflect the fundamental flow of implicit or explicit income generated by a housing asset. In retrospect that advice looks pretty good, so I am inclined to think in those terms today. A simple back-of-the envelope calculation for this ratio—essentially comparing the path of the S&P/Case-Shiller composite price index for 20 metropolitan regions to the time path of the rent of primary residences in the consumer price index—tells a somewhat different story than the New York Times chart used in the aforementioned Ritholtz blog post:

According to this calculation, current prices have nearly returned to levels relative to rents that prevailed in the decade prior to the housing boom that began in the late 1990s.

Of course, the price-rent ratio is not the most sophisticated of calculations. David Leonhardt shows the results from other such calculations that suggest prices relative to rents are still elevated, at least relative to the average that prevailed in the 1990s. But the adjustment that would be required to bring current levels back into line with the precrisis average is still much lower than suggested by the Ritholtz graph.

How much farther prices fall is, I think, critical in the determination of how the economy will fare in the immediate future. Again, from President Lockhart:

"The housing sector also has indirect impacts on the economy. In particular, the direction of home prices is important for the economy because changes in home prices affect the health of both household and bank balance sheets. …

"The indirect influence of the housing sector on consumer activity and bank lending would almost certainly aggravate housing's impact on growth."

Here's hoping my chart is more predictive of housing prices than the alternative.

Update: The Calculated Risk blog does a thorough job and concludes that we don't have "to choose between real prices and price-to-rent graphs to ask 'how far out of line are house prices?' I think they are both showing that prices are not far above the historical lows."

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I am trying to sell a house myself right now, and was shocked at the crash in housing values we see in our area (midwest). I'm seeing projections of 25% - 33% loss of value since 2006.

Unfortunately, I think prices have a ways to go before bottoming out. In my area, there are 18 months of housing stock on the market right now. We're competing with cheap foreclosures and short sales (both are at historic highs right now, I believe). In 2004, it took about 30 days to sell a house. Now it takes about 250 days. Try selling when you need to move immediately for a job opportunity.

Linking housing prices to rents might work in the "normal" environment. But we're so far outside of normal now that I think you're over-optimistic in your projections.

What historical period has had such a number of underwater mortgages? And isn't that all thanks to the models that assumed housing prices never diminished?

Economic models need to be revised to reflect current reality. Using a model that "is not the most sophisticated of calculations" won't get us out of this catastrophe. But it's certainly nice wishful thinking....

As long as we live in a world where interest rates never deviate from the current level, then "prices are in line with rent" If, however, for any reason interest rates may move towards long term trend lines...then it would be prudent to look at prices as a derivative of interest rates...in which case they are probably still far higher than a "normal" market could bare.

My neck of the woods, Sonoma, Calif property provides an indication of what direction other markets might experience when if ever foreclosure/distressed homes become a small percentage of the market. My upscale 55+ area has a good number of homes for sale and few are selling, prices continue to decline slowly but on a steady pace. Economist and others expect prices to hold or go up once the foreclosure process has run its course but the reality is that home prices are way out of line with income including price rent ratios. When using a price rent ratio use 100 times monthly rent as a baseline to get a good idea what local home prices should be. In my area most of these homes rent for about $1600 a month and owners try and sell between 350K and 500K, so based on the rent market these homes need to sell in the 160K range which is a long way from there bubble high of 650K or even current market prices which reflects a slow market. Maybe when and if these properties get down to reasonable price rent ratios they will sell.

"Here's hoping my chart is more predictive of housing prices than the alternative."

Isn't there something odd about senior employees of the Federal Reserve, the institution charged with primary responsibility for preserving the purchasing power of our currency, cheering (asset price) inflation?

Over and over again analysts use price/rent as if RENT was some kind of cosmic truth telling measure of value. Rents are quite volatile. Every bit as volatile as housing prices (if not more so). They very tremendously even within a small geographic area. The types and quality of rental housing also varies depending on when properties were built.

RIGHT NOW RENTS ARE WAY UP (in many areas) and vacancies are down. This is out of line with historical employment vs rent trends. These high rents obviously distort the price/rent ratio and there is no reason whatsoever to imagine that rent levels provide more truth of value than the housing prices themselves.

I think the above comments are a better indicator of what is really happening in today's real estate market than are models based upon historical data that is not likely to be repeated anytime soon.

I use proprietary software from foreclosureradar.com (I have no financial interest in the site) and the volume of REO inventory, both current and in the pipeline is staggering in California. As short sales and REO re-sales re-set the comparable prices, sellers are being forced to accept lower and lower prices because their homes otherwise won't appraise at the contracted sales price.

Based upon this data, prices are now back to 2000 and the "deals" can be had for 1996 prices. I suspect we have a few more years, and perhaps another recession, before it will be time again to buy.

The interesting thing about price to rent measures is how different they are geographically. The areas that are clearly in a housing oversupply situation are incredibly cheap to buy vs rent (think of renting as buying plus buying a put on the house struck at the market) whereas other areas that are in "relative" equilibrium are not at all cheap on a buy vs rent measure. As an example take a look on zillow at the price of a three bedroom house in Dearborn Mi. How this all sorts itself out will be an interesting experiment. In the absence of easy (IE: high LTV-No doc) lending, the most reasonable hypothesis is much lower prices.

In parts of metro-Denver, rents are above my value to rent formula: value/income = 1 percent. I have used this formula for over 40 years so I haven't purchased but only a few Denver properties in the last 20 years. Now I am purchasing properties again but one has to be keenly aware of declining value neighborhoods and rising expenses but property taxes are declining.

@Main Street Muse. The price to rent ratio is just that, a ratio independent of interest rates at the time. I believe your suggestion is more in line of a housing affordability index, which takes into consideration the interest rate and therefore monthly payment at the time. Using that measure of affordability, buying a house is actually more affordable now than in the past because of current low rates. In other words, we are back to long term trend in price to rent ratio, but still below long term trend in interest rates, which indicates we have some padding to absorb an increase to historical 7%.

Another thought about the "bottom." Distressed properties pulling prices down significantly. Agreed. But, doesn't the price of new construction ultimately determine the long term "price point" of the market with "used" homes selling on average 15-20% below new construction for the same quality and square footage? Assuming a continued expansion in the population, the recycling of current inventory, or washing out of the shadow inventory will only last so long before new houses must be built. New construction has an absolute cost in terms of labor and commodities. Would be interesting to see a trend line of the cost of new construction per square foot over time.

Property prices in desirable parts of California probably will never stabilize at 100 months rent because of combination of premiums buyers are willing to pay and the distortions caused by prop 13. However, long-term prices have tracked around 4x income and hit around 10x during the bubble. So that might predict a $650K bubble house going for about $250k

I am rather puzzled as to what the rent valuations are based on. AFIK there is no mechanism that requires landlords to report to any centralized statistical agency what rents their tenants are actually paying, along with information that would permit comparison to actual sale prices for comparable homes. Here in the northwest suburbs of Chicago, at bubble peak there were hardly any single-family homes for rent, and none comparable to mid- to high-end properties. Homes that in the past might have been rentals had been bought up by flippers and were being rehabbed -- or torn down to be replaced with million-dollar McMansions.

Now, there is a glut of homes for rent, but nearly all at prices that reflect not what the market will pay, but rather what the homeowner needs to pay their mortgage and taxes. As the owners are not business-people and are in a state of denial, they refuse to lower the asking rent, preferring zero income to any income less than mortgage plus taxes. So one finds the same homes on the MLS rental pages six months, nine months, or even more. Recently, one sees an occasional reduction in asking rent --- but not enough to move the property. I suspect that many of the homes that have disappeared from the MLS rental listings have disappeared not because they were rented, but because they were finally foreclosed upon. But if they were rented, I suspect it was at a monthly rate well below the asking rent.

So if the rents used for the price-to-rent ratio calculation are the MLS asking rents, they are probably significantly overstated.

Moreover, since the market is obviously not clearing at the rents being currently being asked, actual rents will have to end up significantly lower than the rents currently being paid for the homes that do rent, if the additional homes (which are effectively a "shadow inventory") are ever going to actually be rented.

Zillow is half the problem. They estimate my house on the basis of never seeing it, nor ever seeing the improvements I've made. They have a statistical model they follow, but I own a ranch house on a full ace, and in my area there are probably 1 or 2 similar houses for sale, so there is no statistically valid sample to put into their model.

The other half is the estimators that do the same thing. They don't look at a house, they don't have a valid statistical sample, so there numbers are irrelevant.

The value of a house is what a buyer and seller say it is. The only other basis to use is build or rebuild cost. So, let's be honest, the system is the problem.

If you really want to solve he problem, reenact Glass Steagall, thereby forcing the banks to lend money in order to make a profit instead of gambling on derivatives. They don't lend, they die. As Ben Johnson said, "The prospect of hanging has a way of concentrating the mind."

@Virginia - "Using that measure of affordability, buying a house is actually more affordable now than in the past because of current low rates."

If you are a first time buyer, this could be an okay time to buy - but prices are still significantly higher than in the late 1990s, and it seems that they will continue to decline through the next 12 - 18 months. And employment uncertainties/wage stagnation could make buying a bit tricky today.

If you are NOT a first time buyer, but a homeowner looking to sell, the price to rent ratio is irrelevant. The market value of your home has tanked significantly in the last few years. That's a serious decline in the net worth of a middle-class home owner.

The price/rent ratio probably should not compare the price to rent of equivalent houses. I am a renter now, but if I ever do decide to buy a house, I would buy a house much larger than the one I am renting now.

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May 11, 2011

Is housing hurting the recovery?

"Home values fell three percent in the first quarter of this year, marking a pace of decline not seen since 2008 when the housing recession was at its worst. Home values fell one percent between February and March and 8.2 percent from March 2010."

"Previously, we anticipated a bottom in home values by the end of 2011. But with values falling by about 1 percent per month so far, it's unlikely that will happen. We now believe a bottom will come in 2012, at the earliest."

"To be sure, housing prices have fallen this year. But the Zillow numbers out today make the housing market look worse than it is. The problem is with how Zillow tracks home prices. Unlike other measures of the housing market, Zillow's numbers are not based on actual sales, but on estimates of what its model thinks your house, along with every other house in America is worth. Zillow's model is similar to how an appraiser figures out what your house is worth. It looks at past sales of houses that are similar to yours and then guesses what your house is worth. But by the time those sales are fed into Zillow's system they are months old. … If the housing market is turning, Zillow is going to miss it."

Is the housing market turning, particularly with respect to prices? Tough to say. If you want your glass half full, these words from the New York Fed's Liberty Street Economics might be the tonic for your tastes:

"This post gives our summary of the 2011:Q1 Quarterly Report on Household Debt and Credit, released today by the New York Fed. The report shows signs of healing in household balance sheets in the United States and the region, as measured by consumer debt levels, delinquency rates, foreclosure starts, and bankruptcies…

"Delinquency rates are generally down…

"New foreclosures fell nationally and in the region. About 368,000 individuals in the United States had a foreclosure notation added to their credit report between December 31 and March 31, a 17.7 percent decrease from the 2010:Q4 level. New foreclosure rates fell from 0.19 percent to 0.15 percent for all individuals nationwide…"

What may be the most important aspect of the report is highlighted by the Financial Times's Robin Harding: "…fewer new mortgages going bad, and some bad mortgages getting better." In fact, for the first time since the crisis began, the percentage of mortgages transitioning from 30 to 90 days delinquent to current exceeds the percentage transitioning to seriously delinquent (90-plus days).

"Most analysts now expect that the housing market won't bottom out until sometime next year. Until that happens, it's unlikely that that the sluggish economic recovery we're seeing right now will improve much."

"…can we have high-quality growth while the residential real estate and commercial real estate sectors continue to be so weak? Not completely, in my opinion. The recovery will progress, but it will not be robust until we work through the economy's serious imbalances, including those in the real estate sector.

"As I look ahead, I think the most reasonable assumption is that improvement of the real estate sector will lag an otherwise improving economy. But I am encouraged by the fact that the economy is increasingly on firmer footing."

I will let you decide whether that glass is half-empty or half-full.

By Dave Altig
senior vice president and research director at the Atlanta Fed

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Comments

the accelerating decline in housing prices is really old news, and its not just zillow that's been reporting it; corelogic reported a 1.5% decline in March, which put their index 4.6% below the 2009 lows; the NAR index has fallen 7% YTD, and is also 4.6% below last years reading; and just last week, clear capital declared an official double dip, after their index fell 4.9% from the previous quarter and 5.0% YoY...

I'm voting for half empty. And I think it will take more than just a year before housing recovers to the point it will have a significant positive impact on the economy. So I’m projecting a slow choppy recovery for the U.S. economy.

US government has stimulate the economy with 4.5 trillions of dollars or so and its only stimulated the economy half cos it bail out the big co. only . The main contributor of US economy , consumers are left in debt . They need to be bailed out so that economy will be balanced.

I'm going to have to agree with the half empty comment. I think it is true that we are a long ways away from the economy going up. Not only is housing suffering, but business owners as well. Hopefully change will come soon.

Another hand for half empty. It's really hard to recover from economic downfall. I don't think housing is the mainstream of this. Rapid growth of population and cost cutting also affect the chance of regaining it back.

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